Friday, July 13, 2012

"...we can easily see another fraudulent practice that HHB should object to equally strenuously: fractional reserve gift certificating.
Look at the deceit involved in this nefarious practice: a local
restaurant at Christmas time sells gift certificates for 1000 prime rib
dinners, and yet... there are not 1000 prime rib dinners in the
restaurant at the moment they sell them! In fact, never are there more
than fifty or so in the restaurant at any one time. The crooked owners
of this restaurant, of course, will try to hide their deceit behind some
spurious claim like, "Based on past gift certificate programs, we
expect redemptions of about 100 meals per week, and we have plenty of
beef on hand to meet that demand.""

It's a great response to an argument that seems like it is increasingly grasping at straws.

The "you can't have two people own the same thing" argument that Gene is responding to is actually pretty creative and clever (not quite clever enough, but clever). But it's a little roundabout, precisely because the naive arguments against fractional reserve banking are so bad. You would think that the obvious response to a claim of fraud is whether people understand what's going on or not. If they know what's going on, it's hard to claim that they've been defrauded. Fraud implies that someone has had the wool pulled over their eyes.

So do people know what's going on? Of course they do. Ask an elementary schooler if the bank has everyone's money locked up away in the vault and they might be confused and think it is. But you can't circulate in modern society very long without having some inkling of the operation of fractional reserve banking.

If you're aware of the practice, how can you be said to have been defrauded? You can't! People are implicitly but knowingly told that the bank will hold their money but that if everyone comes at once the bank may not have all that money on hand. We tell that story in children's stories and Christmas stories like Mary Poppins and It's a Wonderful Life, after all! You can take that deal or you can leave it - and if you're a real stick in the mud you can google what that FDIC sticker on the bank window is all about - but people are aware of the nature of the deal. If you're aware of it, it's not fraud.

Of course, if it's not fraud by this very obvious standard for "fraud", Rothbard and the rest of them start to look a little sillier (if that's possible). Hence, the resort to more creative arguments like "two people can't own the same thing".

24 comments:

"The 'you can't have two people own the same thing' argument that Gene is responding to is actually pretty creative and clever (not quite clever enough, but clever). But it's a little roundabout, precisely because the naive arguments against fractional reserve banking are so bad."

It's an old argument I've encountered it many times.

There are many situations, such as normal mortgages, where one party owns a property and another party can take possession of it. In FR banking that other party can take possession of it at any time. This doesn't change the basic situation or mean that two people own the same piece of property.

There again, it's quite true that people are confused about fractional-reserve banking. Anthony Evans and the Cobden Centre did some research on this using questionnaires and it's quite clear that lots of people don't understand it.

If anyone is interested in this argument see this comment thread I took part in last year which covers a lot of the common arguments:http://www.countingcats.com/?p=11179

I'd believe a lot of people don't understand the fractional reserve banking system. But surely the share of adults who actually don't understand that the bank doesn't just leave everyone's money in the vault is very small, right?

Even if they did, the fraud argument is quite weak. I don't understand on a truly fundamental level how my TV works or my computer works. I may have a sense of the technology, but I don't really understand. But I have an expectation of what I have a claim to in buying the product. I'm not buying a particular mechanism for delivering that claim because I'm not competent to judge that mechanism.

That doesn't mean I'm being defrauded.

(I'm just thinking out loud - I'm not saying you'd dispute the point).

Like Gene Callahan and Daniel Kuehn, I agree that charges that fractional reserve banking is fraudulent to be incorrect. However, I might add the position of Dr. Michael Emmett Brady: the problem is not the fractional reserve banking itself per se, it's when bankers lend to speculative actors, or worse, become excessively speculative themselves.

Brady's position doesn't seem to be a complete one. You can't a priori assume that speculation is bad. Speculation can have a real function, and that is to provide intertemporal equilibrium. For example, if a net positive quantity of speculators expect the price of wheat to double by next year, then the present price of wheat will rise to reflect this. Speculators, if successful, can act to smooth the market process. The real question is: why did so many speculators made poor speculations?

I think the problem with Gene's analogy is that it implicitly assumes that the 'FRB is fraud' position is that money deposited in a bank should become the property of the bank. That is, it shows up on the banks balance sheet as an asset. This is not the 'FRB is fraud' position. Their position is that the amount of money deposited at the bank (the amount, not the particular money deposited) remains the property of the depositor (and thus should not show up on the banks balance sheet). That is why they say ‘two people can’t own the same thing.’

I think the ‘FRB is fraud’ crowd agrees that a business that received payments for gift certificates would indeed own the money they received and that money would be an asset on their balance sheet. It is no longer ‘owned’ by the purchaser, but by the business. Therefore two people do not own the same thing. If banks also owned the money they receive from the depositor, then, the comparison Gene makes would be appropriate. But, that position is already at odds with the 'FRB is fraud' position before drawing the analogy.

That's pretty consistent with what I've encountered when debating the 'FRB is fraud' crowd. (is there another name for their position? It's pretty unwieldy to keep typing.) I think that's also the underlying problem with their position. Their position is analogous to going to a zuccini merchant leaving with a zuccini and clamoring: "You have defrauded me! I wanted a cucumber! How dare you give me a zuccini?" And when the rest of us try to explain that they went to a zuccini merchant, they clamor some more "You're assuming I went to a zuccini merchant instead of a cucumber merchant who defrauds everyone by giving them zuccinis!" That's usually when I give up.

Assuming that the banker and depositor can work out a mutually agreeable contract for some form of "fractional reserve free banking", what information is to be provided to the prospective payee of these "fractional reserve notes"? Is that information going to appear on the face of the note? What does the note promise on its face? What level of understanding do you expect payees to possess regarding the significant difference between a "fractional reserve note" and a 100% reserve note?

Dr. Brady isn't opposed to speculation itself. He's opposed to it when it's financed by the banking system. He is not opposed to it when people are speculating with their own money rather than a loan from a bank.

That still isn't sufficient. When you borrow from a bank you're expected to repay; if you don't repay then the bank takes from your pool of assets. If you don't have assets, the bank has no business lending you money. So, there's still some fundamental questions that these simplistic analyses aren't answering.

Money is a present good. Parking spaces, airline seats, insurance claims, and even gift certificates for steaks all represent future goods. By overissuing titles to present, yet indirectly serviceable goods - money - banks are immediately and incontrovertibly engaged in fraudulent behavior. Hoppe dealt with this in the EXACT same article Gene attacks. Leave it to Callahan to miss something right under his nose.

Gift certificates are every bit as "present" as demand deposits, Mattheus. Steak houses and banks both count on the fact that people will claim them over time, but there's no difference at all in their presentness.

If he maintains the claim that this is fraudulent he clearly hasn't "dealt with this". He may have talked about it, of course.

Assuming that the banker and depositor can work out a mutually agreeable contract for some form of "fractional reserve free banking", what information is to be provided to the prospective payee of these "fractional reserve notes"? Is that information going to appear on the face of the note? What does the note promise on its face? What level of understanding do you expect payees to possess regarding the significant difference between a "fractional reserve note" and a 100% reserve note?

No need to repeat - I saw it. It just didn't seem substantive enough to comment on.

I expect consumers would probably appreciate seeing such information on the face value of a note, fine. If a dual system emerged I imagine that would be reasonable. I think people would understand the difference, don't you?

But once again all contracting parties are aware of the arrangement whereby simultaneous redemption is problematic. So where is the fraud?

It's not fraud if they're all aware. But then it's not money, it's a lottery ticket. If you want to carry around lots of lottery tickets - and people are willing to exchange them for goods and services - okay. But that's a different creature than money per se.

I just don't see this as very likely from a forecasting perspective. Why should everyone in society carry around lottery tickets that have a small chance of being worthless in the event of simultaneous redemption as opposed to a note from a bank that guarantees the safekeeping of one's property? In other words, why would the multitude of market actors that make up the economy prefer a risky property title to a secure one?

There are about three hundred million people in your immediate vicinity you could poll on that question, Mattheus.

As for your last question - the same reason you'd always prefer a risky asset over a secure one: reward. The fact that the particular risk you're referring to has practically no risk sweetens the pot quite a bit, of course.

Because it's much cheaper Mattheus. If the bank was simply a big vault that held all my gold and issued me redemption certificates against my gold, they would most likely charge me for the cost of the vault, the guards, etc... Instead, in an FRB system, they pay me interest in exchange for the really tiny chance that my money will become worthless. A chance that is not really much higher than the chance that an earthquake will swallow the vault with all my gold in it or that some thieves will steal the gold or whatever. As for whether this is money or not, the question is moot. We've decided as users of the English language that it is called money. Is it a different beast than gold-backed certificate for sure. But it is most definitely money.

Fractional reserve notes have been exchanged for money for many hundreds of years. Mises called them "money substitutes" for this reason. Whatever your view of what money in the strictest sense is they are money in the broader sense. You should read "The Theory of Money and Credit" on this issue, it might not say what you expect :)

As PrometheeFeu mentions the reasons for this are quite clear. A bank account offers banking services, either for free or for small fees. This is funded by the returns from lending. The user of a bank account takes extra risk in return for these services. If banks were 100% reserve then fees for banking services would be much higher (and there would be storage fee though these would likely be small). The practical risk of bank going bankrupt can be made quite small through careful selection of assets and careful provisioning of reserves.

I used to have a small place in New Mexico. Shortly after moving in I noticed people walking along a path at the edge of my property, within my fence. It did not particularly bother me, but I asked my lawyer about it. He explained that they had the right to do so. (There were some onerous actions that I could take that might allow me to keep them out, which would take their tacit assent.) Who owned the path? It would be silly to say that I did, just because I held legal title to it. It was a kind of common property.

What would happen if those people decided to open a mine under this path? Or if they decided to build a small building on the path?

You are right in a way, some previous owner or the state, have declared that the right to walk on a portion of land is common. But this doesn't affect the other rights the owner has. Sometimes though it makes those rights meaningless.

Jonathan Finegold Catalan: The private banking industry, at least according to Dr. Michael Emmett Brady, often lends to speculators because it maximizes short-term profits. "Simplistic analyses"? Perhaps I've over-simplified Dr. Brady's position, and perhaps it would be better if you corresponded with him so that you could try to understand his position (I've given you his e-mail address before). Dr. Brady seems to believe that trying to contain risk-taking so that it doesn't create a situation that one would call "Ellsbergian ambiguity" or "Keynesian uncertainty". Adam Smith, if I'm not wrong, analogized the banking system to the circulatory system of the whole economy. Lending to speculators can eventually cause over-leveraging.